Pension Issues

Submitted to the
Subcommittee on Oversight
Committee on Ways and Means

Statement of the
Investment Company Institute

March 23, 1999

The Investment Company Institute¹ is pleased to submit this statement to the Subcommittee on Oversight of the House Committee on Ways and Means to address retirement savings issues raised at its March 23 hearing. Most importantly, we would like to take this opportunity to indicate our strong support for many of the provisions of H.R. 1102, the "Comprehensive Retirement Security and Pension Reform Act of 1999." H.R. 1102 would make the nation’s retirement plan system significantly more responsive to the retirement savings needs of Americans. The Institute commends the sponsors of this bill and other members of this subcommittee for their interest in retirement savings policy.

Retirement savings is of vital importance to our nation’s future. Although members of the "Baby Boom" generation are rapidly approaching their retirement years, recent studies strongly suggest that as a generation, they have not adequately saved for their retirement.² Additionally, Americans today are living longer. Taken together, these trends will place an enormous strain on the Social Security program in the near future.³ In order to ensure that individuals have sufficient savings to support themselves in their retirement years, much of this savings will need to come from individual savings and employer-sponsored plans.

The Institute and mutual fund industry have long supported efforts to enhance the ability of individual Americans to save for retirement in individual-based programs, such as the Individual Retirement Account or IRA, and employer-sponsored plans, such as the popular 401(k) plan. In particular, we have urged that Congress: (1) establish appropriate and effective retirement savings incentives; (2) enact saving proposals that reflect workforce trends and saving patterns; (3) reduce unnecessary and cumbersome regulatory burdens that deter employers—especially small employers—from offering retirement plans; and (4) keep the rules simple and easy to understand.

It is our view that H.R. 1102 achieves these objectives.

Establish Appropriate and Effective Incentives to Save for Retirement

In order to increase retirement savings, Congress must provide working Americans with the incentive to save and the means to achieve adequate retirement security. Current tax law, however, imposes numerous limitations on the amounts that individuals can save in retirement plans. Indeed, under current retirement plan caps, many individuals cannot save as much as they need to. One way to ease these limitations is for Congress to update the rules governing contribution limits to employer-sponsored plans and IRAs. Increasing these limits will facilitate greater retirement savings and help ensure that Americans will have adequate retirement income.

H.R. 1102 contains several provisions that would address this issue, which the Institute strongly supports. Section 101 of the bill would increase 401(k) plan and 403(b) arrangement contribution limits to $15,000 from the current level of $10,000; government-sponsored 457 plan contribution limits would increase to $15,000 from the current level of $8,000. Section 101 also would modify the Section 401(a)(17) limit on compensation that may be taken into account to determine benefits under qualified plans by reinstating the pre-1986 limit of $235,000, indexed in $5,000 increments. The current limit is $160,000. Another important provision of H.R. 1102 would repeal the "25% of compensation" limitation on contributions to defined contribution plans. These limitations can prevent low and moderate-income individuals from saving sufficiently for retirement. (As is noted below, the repeal of these limitations is also necessary in order to enable many individuals to take advantage of the "catch-up" proposal in the bill.)

In addition to these proposals, the Institute urges Congress to increase the IRA contribution limit. The IRA limit remains at $2,000—a limit set in 1981. If adjusted for inflation, this limit would be at about $5,000 today. IRAs are especially important for individuals with no available employer-sponsored plan through which to save for retirement. H.R. 1102 proposes such an increase, but limits its availability only to individuals able to make a fully deductible contribution under current income-based eligibility rules.

This targeted approach complicates these rules, which already are too confusing. Indeed, when Congress imposed the current income-based eligibility criteria in 1986, IRA participation declined dramatically—even among those who remained eligible for the program. At the IRA’s peak in 1986, contributions totaled approximately $38 billion and about 29% of all families with a head of household under age 65 had IRA accounts. Moreover, 75% of all IRA contributions were from families with annual incomes less than $50,000.⁴ However, when Congress restricted the deductibility of IRA contributions in the Tax Reform Act of 1986, the level of IRA contributions fell sharply and never recovered—to $15 billion in 1987 and $8.4 billion in 1995.⁵ Among families retaining eligibility to fully deduct IRA contributions, IRA participation declined on average by 40% between 1986 and 1987, despite the fact that the change in law did not affect them.⁶ The number of IRA contributors with income of less than $25,000 dropped by 30% in that one year.⁷ Fund group surveys show that even more than a decade later, individuals do not understand the eligibility criteria.⁸

Based on these data, the Institute recommends that the increase in the IRA contribution limit that is proposed in H.R. 1102 be extended to all taxpayers by repealing the complex eligibility rules, which deter lower and moderate income individuals from participating in the program. A return to a "universal" IRA would result in increased savings by middle and lower-income Americans.

Enact Savings Proposals That Reflect Workforce Trends and Savings Patterns

On average, individuals change jobs once every five years. Current rules restrict the ability of workers to roll over their retirement account from their old employer to their new employer. For example, an employee in a 401(k) plan who changes jobs to work for a state or local government may not currently take his or her 401(k) balance and deposit it into the state or local government’s pension plan. Thus, the Institute strongly supports Sections 301 and 302 of H.R. 1102, which would enhance the ability of American workers to take their retirement plan assets to their new employer when they change jobs by facilitating the portability of benefits among 401(k) plans, 403(b) arrangements, 457 state and local government plans, and IRAs.

The laws governing pension plans also must be flexible enough to permit working Americans to make additional retirement contributions when they can afford to do so. Individuals, particularly women, may leave the workforce for extended periods to raise children. In addition, many Americans are able to save for retirement only after they have purchased their home, raised children ,and paid for their own and their children’s college education. Section 201 of H.R. 1102 would address these concerns by permitting additional salary reduction "catch-up" contributions. The catch-up proposal would permit individuals at age 50 to save an additional $5,000 annually on a tax-deferred basis. The idea is to let individuals who may have been unable to save aggressively during their early working years to "catch up" for lost time during their remaining working years. Section 202’s repeal of the "25% of compensation" limit could further enhance the ability of Americans to "catch-up" on their retirement savings.

The "catch-up" is an excellent idea and sorely needed change in the law. We believe it could be made even more effective by exempting the catch-up contributions from nondiscrimination testing. A similar proposal is contained in S. 646, the "Retirement Savings Opportunity Act of 1999," introduced by Senator Roth (R-DE) and Senator Baucus (D-MT).

Expand Retirement Plan Coverage Among Small Employers

The current regulatory structure contains many complicated and overlapping administrative and testing requirements that serve as a disincentive to employers, especially small employers, to sponsor retirement plans for their workers. Easing these burdens will promote greater retirement plan coverage and result in increased retirement savings.

Meaningful pension reform legislation must focus on the need to increase pension plan coverage among small businesses. Although these businesses employ millions of Americans, less than 20 percent of them provide a retirement plan for their employees. By comparison, about 84 percent of employers with 100 or more employees provide pension plans for their workforce.⁹

Unnecessarily complex and burdensome regulation continues to deter many small businesses from establishing and maintaining retirement plans. The "top-heavy rule" is one example of such unnecessary rules.¹⁰ A 1996 U.S. Chamber of Commerce survey found that the top-heavy rule is the most significant regulatory impediment to small businesses establishing a retirement plan.¹¹ The rule imposes significant compliance costs and is particularly costly to small employers, which are more likely to be subject to the rule. It is also unnecessary because other tax code provisions address the same concerns and provide similar protections. While the Institute believes the top-heavy rule should be repealed, Section 104 of H.R. 1102 would make significant changes to the rule, which would diminish its unfair impact on small employers.

H.R. 1102 also would reduce the start-up costs associated with establishing a pension plan for small employers by providing a tax credit to small employers of up to 50% of the start-up costs of establishing a plan up to $1,000 for the first credit year and $500 for each of the second and third year after the plan is established. This would encourage more small employers to establish retirement plans by diminishing initial costs.

The Institute also strongly supports expanding current retirement plans targeted at small employers. Specifically, the Institute supports expansion of the SIMPLE plan program, which was instituted in 1997 and offers small employers a truly simple, easy-to-administer retirement plan. The SIMPLE program has been very successful. An informal Institute survey of its largest members found that as of March 31, 1998, these companies were custodians for an estimated 63,000 SIMPLE IRA plans and approximately 343,000 SIMPLE IRA accounts. The SIMPLE program is especially popular among the smallest employers—those with under 25 employees. Indeed, the vast majority (about 90%) of employers establishing these plans have under 10 employees.

H.R. 1102 would strengthen the SIMPLE program in two ways, each of which the Institute strongly supports. First, H.R. 1102 would raise the SIMPLE plan contribution limits from $6,000 to $10,000. This would address the current "penalty" to which individuals who work for a small employer are subject. Individuals should not be disabled from saving for retirement merely because they work for a small employer. Second, H.R. 1102 would provide for a salary-reduction-only SIMPLE plan. This would make the program much more effective for employers of 25-100 employees.

Simplify Unnecessarily Complicated Rules

H.R. 1102 recognizes the need to keep the rules simple in the case of both IRAs and employer-sponsored plans. As we have noted above, complex and confusing rules diminish retirement plan formation and significantly reduce individual participation in retirement savings programs. We strongly support numerous provisions in H.R. 1102 that would simplify rules. We discuss several of these provisions below.

Section 205 of the bill would simplify the required minimum distribution rules applicable to distributions from qualified plans and IRAs. The bill would exempt from the rule the first $100,000 of assets accumulated in an individual’s defined contribution plans and the first $100,000 accumulated in an individual’s IRAs (other than Roth IRAs, which are not subject to the rule). This proposal provides individuals with smaller account balances with relief from a complex and burdensome rule.

The bill also would provide a new automatic contribution trust nondiscrimination safe harbor. This safe harbor would simplify plan administration for employers electing to use it, enabling them to avoid costly, complex and burdensome testing procedures.¹² This provision is also an effective way to increase participation rates in 401(k) plans, especially the participation rates of non-highly compensated employees.

H.R. 1102 also would modify the anticutback rules under Section 411(d)(6) of the Internal Revenue Code in order to permit plan sponsors to change the forms of distributions offered in their retirement plans. Specifically, the bill would permit employers to eliminate forms of distribution in a defined contribution plan if a single sum payment is available for the same or greater portion of the account balance as the form of distribution being eliminated. This proposed modification of the anticutback rule would make plan distributions easier to understand, reduce plan administrative costs, and continue to adequately protect plan participants. In addition, H.R. 1102 would permit account transfers between defined contribution plans where forms of distributions differ between the plans; this modification of the anticutback rule also would simplify plan administration. It would also enhance benefit portability, which, as noted above, is an important public policy objective.

Finally, H.R. 1102 contains other provisions that would simplify currently burdensome rules and which the Institute supports. These proposals include repeal of the multiple use test and simplification of the separate line of business rules.

Conclusion

Improving incentives to save by increasing contribution limits and accommodating the saving patterns of today’s workforce will provide more opportunities for Americans to save effectively for retirement. Simplifying the rules applicable to employer-sponsored plans and IRAs would result in a greater number of employer-sponsored plans, a higher rate of worker coverage, and increased individual savings. The Institute strongly supports the provisions described above and commends the sponsors of H.R. 1102 for supporting reforms of the pension system that will increase plan coverage and encourage Americans to save for their retirement. We encourage members of this Committee and Congress to enact this legislation this year.

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